August 11, 2008
Over the years short-selling has become a major trading vehicle for driving the stock of weak business entities into the ground. No one disputes that short-selling is a valid market mechanism. However, when large amounts of stocks are shorted (ala naked) large amounts of stock need to be borrowed. Under these volume circumstances brokerage firms have been "lax" in finding borrowed stocks at the time of a trade to match naked shorts (and even failed to deliver 72 hours later). What this means is that brokerages have inadequate systems and processes to handle naked short-selling.
What's more important is that this gives shorts an unfair market advantage over longs. A long buyer must find a seller for a trade to be consummated even if it is a market-maker. Why shouldn't a short-seller be obligated to find a stock lender before a short-sale can be consummated? The key to this argument is "BEFORE" a trade is about to be made. The SEC rule is right-on and should be expanded to all stocks.
What this rule change has brought out is that the process of matching borrowed stock to short sales is not up-to-par (manual and costly) and that brokerages handling short trades require a lot of upgrading to their systems and processes. Needless to say, upgrades will be very costly and who should pay these upgrade costs? Of course, short traders should pay for services they use. Also, it hasn't come out yet, but if millions of shares are being shorted and those shares need to be borrowed, the owners of those shares may well expect to be compensated for lending their stocks (and rightly so). Who should pay for borrowing a stock? Of course, short-sellers should pay for this service too. Now it should become clear how "naked" short-sellers have had an unfair advantage in this type of trading up-to-now.
When short-trading was just a few thousand shares here-and-there naked short-selling may not have been a big deal but now that it's millions of shares it IS a big deal. Neither naked short-sellers nor their brokerages want to step up to this reality because it means costly and drastic changes to their systems, operations, and profits. The SEC should not only keep this rule change but expand it to all stocks so that the stock market is fair and level for both longs and shorts!
Steve from Atlanta